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REAL ESTATE MERCHANT BANKING
In the first few weeks of 2016, we have seen the stock market retreat due to global economic and geopolitical uncertainty. This uncertainty has promoted a flight to safety that, in turn, has caused treasury yields to drop 28 basis points since the start of the year. While the drop in treasuries is generally a good thing for real estate capital markets, investors and developers, it has had a profound impact on CMBS lenders who have not seen this kind of rate volatility in quite some time.
In this month’s publication we discuss how construction lenders, CMBS originators and B-Piece buyers are adjusting to the volatility in the bond market and the pending implementation of new regulation, as well as the federal banking agencies’ hawkeyed statement for risk management in commercial real estate lending.
Construction & Bridge Lender Survey
Dekel Capital recently conducted a comprehensive survey of construction lenders. Market sentiment is positive and the expectation is for another busy year. Market volatility in the past six months is recognized but market specific growth drivers remain robust and new projects are being underwritten to trended market rent and absorption levels.
The national banks, regional banks, and debt funds that fueled the boom in construction and heavy value-add projects through the end of 2015 have not lost momentum, maintaining a strong appetite for construction lending with a focus on residential, creative office, and hospitality projects. With an eye on adjusting exposure among product types, lender feedback in the new year indicates a desire to deploy more capital into student housing and senior housing, as well as, for retail – assuming strong preleasing in place prior to breaking ground. Specifically, one regional lender has indicated they have a new allocation of $100M of non-recourse construction financing for new student housing developments. Recourse lenders are maintaining their sizing parameter at 75% of project cost, with non-recourse lenders coming in slightly tighter.
Bridge lenders are also seeing increased activity as borrowers with maturing CMBS loans are looking for alternatives in the short term. Bridge funds are well capitalized and have the capacity to lend across all product types at competitive floating rate pricing.
CMBS Lenders Adjusting to Volatility
The continued volatility of the bond market has affected borrowers and places pressure on originators that have to hold loans on their books for any protracted period of time – 30 days or more. This has been a distinct advantage for the larger originators as they are frequently out to market faster than the smaller origination groups.
Yesterday, the 10-year treasury fell below 2% for the second time this month, a drop of 28 basis points since the start of the year and its lowest level since October 2014. The sharp decline was matched by increases in AAA spreads as investors in the top rated tranches hit their yield floors thereby causing CMBS spreads to widen accordingly, and many CMBS lenders to adjust their quoted spreads in applications. This spread adjustment has hurt borrowers in process with CMBS loans who would usually benefit from declining treasury rates.
While 2015 proved to be a difficult year for a number of CMBS originators, CMBS is still a great option for high leverage, long-term, non-recourse and cheap debt. However, considering the recent volatility and new regulatory pressures impact on originators profitability, we expect there to be some consolidation in the number of CMBS lenders in 2016.
B-Piece Buyers Required to Hold Positions Long Term
The risk-retention regulations, part of the Dodd-Frank financial regulations that ensure B-piece buyers hold B-pieces for at least five years, amongst other things, are set to take effect in December 2016. As this date approaches, many buyers and investors are gaining a clearer idea of how the regulations impact them, specifically the five-year hold mandate after purchasing the bottom five percent of a securitization.
Investors usually retain the unrated notes and single B-class for their high yields and fee-rich, special-servicing rights and look to sell single some B-notes and low-yielding B-class to infuse fresh capital for new purchases. However, the regulations stipulate that B-pieces must be sold intact, unless two-thirds of the collateral balance has been retired which can be more than five years due to limited amortization in conduit deals and loan extensions. This results in B-piece buyers retaining the bonds for the life of the loan or more and in some cases, lock up a B-piece buyer’s investment for more than a decade. As we get closer to the regulation start date, we may see B-piece buyers changing to a long-term hold strategy and setting up strategic long-term funds.
Agencies Statement on Prudent Risk Management for CRE Lending
As 2015 concluded, federal banking agencies issued a joint statement cautioning the commercial real estate industry and explaining how they will be proactively monitoring financial institutions using risk management practices. The decision came as a result of the agencies’ increased suspicion that CRE’s recent lending growth might not be sustainable long term. The market, driven by historically low cap rates and rising property values, has surged and banks have been lowering underwriting standards to keep up with competition.
The new, prudent risk management practices may slow down CRE lending in 2016 as banks begin to tighten standards under the pressure of federal agencies’ supervision. However, this close monitoring of banks will give non-regulated lenders a prime opportunity to increase their volume throughout the new year.
Click here to read the joint statement.
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If you have a pending transaction in need of financing, contact a member of the Dekel Capital executive team to discuss how we can assist in finding the best capital source for your needs.